Standard Costing and Variances

Standard Costing and Variances: Your Recipe for Success! 🍰

Imagine you’re baking a cake. Before you start, you write down exactly what you need:

• 2 cups of flour ($1 each = $2)
• 3 eggs ($0.50 each = $1.50)
• 1 hour of baking time

This is your recipe plan—your standard cost. But what happens when reality doesn’t match your plan? That’s where the magic of variances comes in!

What is Standard Costing? 🎯

Standard costing is like creating a perfect recipe before you cook.

Think of it this way:

You’re a lemonade stand owner. Before selling any lemonade, you decide:

• Each cup needs 2 lemons ($0.25 each = $0.50)
• Each cup needs 1 tablespoon of sugar ($0.10)
• Making one cup takes 5 minutes of your time ($0.20)

Standard cost per cup = $0.80

Why Do Businesses Use Standard Costs?

Real Example: A toy factory sets a standard: Each toy should cost $5 to make (materials + labor). If a toy actually costs $6, something went wrong. If it costs $4, something went right!

Setting Standards: Writing Your Perfect Recipe 📝

Before you can compare, you need to set your standards. This is like writing the recipe before baking.

The Three Main Standards

graph TD
    A["SETTING STANDARDS"] --> B["Material Standards"]
    A --> C["Labor Standards"]
    A --> D["Overhead Standards"]
    B --> B1["How much material?"]
    B --> B2["What price per unit?"]
    C --> C1["How many hours?"]
    C --> C2["What wage rate?"]
    D --> D1["Fixed costs"]
    D --> D2["Variable costs"]

1. Material Standards

What to decide:

• Quantity: How much material for one product?
• Price: How much does each unit of material cost?

Example: Making a wooden toy car

• Standard quantity: 2 blocks of wood per car
• Standard price: $1.50 per block
• Standard material cost = 2 × $1.50 = $3.00 per car

2. Labor Standards

What to decide:

• Time: How long to make one product?
• Rate: How much do you pay per hour?

Example: Same wooden toy car

• Standard time: 30 minutes (0.5 hours) per car
• Standard rate: $20 per hour
• Standard labor cost = 0.5 × $20 = $10.00 per car

3. Overhead Standards

What to decide:

• Fixed costs (rent, insurance—stay same no matter what)
• Variable costs (electricity—changes with production)

Example: Same wooden toy car

• Standard overhead: $2.00 per car
• Total standard cost = $3 + $10 + $2 = $15.00 per car

Where Do Standards Come From?

Standard Cost Variances: What Went Different? 🔍

A variance is simply the difference between what you PLANNED and what ACTUALLY happened.

Variance = Actual Cost − Standard Cost

The Big Picture

graph TD
    A["TOTAL VARIANCE"] --> B["Material Variance"]
    A --> C["Labor Variance"]
    A --> D["Overhead Variance"]
    B --> B1["Price Variance"]
    B --> B2["Quantity Variance"]
    C --> C1["Rate Variance"]
    C --> C2["Efficiency Variance"]

Two Types of Variances

Material Variances (What You Use)

Material Price Variance (MPV)

Did you pay more or less per unit of material?

Formula:

MPV = (Actual Price − Standard Price) × Actual Quantity

Example:

• Standard price for wood: $1.50 per block
• Actual price paid: $1.70 per block
• Blocks purchased: 100

MPV = ($1.70 − $1.50) × 100 = $20 Unfavorable ❌

You paid $0.20 extra per block. That’s bad!

Material Quantity Variance (MQV)

Did you use more or less material than planned?

Formula:

MQV = (Actual Quantity − Standard Quantity) × Standard Price

Example:

• Made: 50 cars
• Should use: 50 × 2 = 100 blocks
• Actually used: 110 blocks
• Standard price: $1.50

MQV = (110 − 100) × $1.50 = $15 Unfavorable ❌

You wasted 10 blocks. That’s bad!

Labor Variances (Who Makes It)

Labor Rate Variance (LRV)

Did you pay more or less per hour of work?

Formula:

LRV = (Actual Rate − Standard Rate) × Actual Hours

Example:

• Standard rate: $20/hour
• Actual rate paid: $18/hour
• Actual hours worked: 30 hours

LRV = ($18 − $20) × 30 = −$60 = $60 Favorable ✅

You paid less per hour. That’s good!

Labor Efficiency Variance (LEV)

Did workers take more or less time than planned?

Formula:

LEV = (Actual Hours − Standard Hours) × Standard Rate

Example:

• Made: 50 cars
• Should take: 50 × 0.5 = 25 hours
• Actually took: 30 hours
• Standard rate: $20/hour

LEV = (30 − 25) × $20 = $100 Unfavorable ❌

Workers took 5 extra hours. That’s bad!

Interpreting Variances: Detective Work! 🕵️

Finding a variance is only the first step. The real skill is figuring out WHY it happened and WHAT TO DO about it.

The Variance Detective Process

graph TD
    A["Find the Variance"] --> B["Is it Big or Small?"]
    B --> C{Significant?}
    C -->|Yes| D["Investigate Why"]
    C -->|No| E["Monitor & Move On"]
    D --> F["Find Root Cause"]
    F --> G["Take Action"]

Common Causes for Each Variance

Real-World Example: The Toy Car Factory

Let’s say you find these variances:

• Material Price: $500 Unfavorable
• Material Quantity: $200 Favorable
• Labor Rate: $100 Favorable
• Labor Efficiency: $400 Unfavorable

Detective Work:

1. Material Price ($500 U): “We had to rush-order wood at a higher price”
2. Material Quantity ($200 F): “New cutting machine wastes less wood”
3. Labor Rate ($100 F): “Used more apprentices instead of senior workers”
4. Labor Efficiency ($400 U): “Apprentices work slower than planned”

Insight: The cheap labor (favorable rate) caused slow work (unfavorable efficiency). Sometimes one variance explains another!

Key Questions to Ask

Taking Action

For Unfavorable Variances:

• Investigate the root cause
• Train employees
• Negotiate better prices
• Fix equipment
• Update unrealistic standards

For Favorable Variances:

• Understand what went right
• Make it permanent
• Share best practices
• Update standards if needed

Putting It All Together 🎪

Here’s the complete story of standard costing and variances:

1. Set Standards → Write your “recipe” for costs
2. Measure Actuals → See what really happened
3. Calculate Variances → Find the differences
4. Interpret Results → Understand WHY
5. Take Action → Make improvements

The Happy Ending

When you master standard costing and variances:

• You control costs like a pro
• You spot problems before they grow
• You reward good performance
• You make smarter decisions

Quick Summary

Remember: Variances aren’t good or bad by themselves—they’re signals that help you understand what’s happening in your business!

Now you’re ready to balance your books like a champion! 🏆